FIN 3400 Chapter 10 Assignment Questions and Answers- Florida International University
Select all that apply
Which of the following will decrease the
... [Show More] risk level of a firm? Select all that apply.
Multiple select question.
Selling the lowest-risk division
Accepting riskier projects
Accepting a low-risk project
Acquiring a less risky firm
Which one of these best illustrates a probability distribution at it relates to next year's economy?
Multiple choice question.
15 percent chance of a boom and 5 percent chance of a depression
25 percent chance the economy will grow at 5 percent or more
5 percent chance of a depression and 25 percent chance of a recession
40 percent chance of recession; 60 percent chance of a normal economy
True or false: The expected return is a forward-looking return that includes risk measures.
True false question.
True
False
Which of these terms best describes an expected return with multiple states?
Multiple choice question.
Historical mean
Geometric mean return
Arithmetic average return
Weighted average return
There is a 75 percent chance the economy will boom and 25 percent chance it will be normal. If it
booms, a stock will return 23 percent but if it is normal, the stock will lose 15 percent. Illustrate the
expected return calculation.
Multiple choice question.
E(R) = (0.75 × 0.23) + (0.25 × -0.15)
E(R) = (0.25 - 0.15) × (0.75 + 0.25)
E(R) = (0.75 × 0.23) × (0.25 × -0.15)
E(R) = (0.75 + 0.23) × (0.25 - 0.15)
Reason:
The expected return is a summation of the probabilities times the returns.
E(R) = (0.75 × 0.23) + (0.25 × -0.15)
Select all that apply
Which of the following will increase the risk level of a firm? Select all that apply.
Multiple select question.
Accepting a low-risk project
Accepting riskier projects
Acquiring a riskier firm
Selling the lowest-risk division
A stock has these expected returns: Boom economy =16 percent; Normal economy = 12 percent;
Recession = -6 percent, There is a 30 percent chance of a boom and a 20 percent chance of a recession.
What is the expected return?
Multiple choice question.
9.6 percent
3.6 percent
9.1 percent
3.2 percent
Reason:
E(R) = (0.30 × 0.16) + (0.50 × 0.12) + (0.20 × -0.06) = 0.096 = 9.6%
Which of these illustrates the definition of a probability distribution?
Multiple choice question.
The sun is shining today and is supposed to shine tomorrow.
It may snow either today or tomorrow.
It rained three-quarters of the day yesterday.
There is a 60 percent chance of rain and a 40 percent chance of pure sunshine.
Select all that apply
The standard deviation of expected returns with multiple economic states considers which of the
following? Select all that apply.
Multiple select question.
The arithmetic average expected return
The expected return for each economic state
The squared value of each expected return
Probability of occurrence for each state of the economy
Which one of these should be used to estimate future stock performance?
Multiple choice question.
Geometric mean return
Total historical return
Arithmetic mean return
Expected return
How is required return defined?
Multiple choice question.
The historical average rate of return
Market rate of return, usually considered to be the S&P 500 return
The return on a security minus the risk-free rate
Total return investors demand as compensation for the risk taken
How do you explain an expected return given multiple states of the economy?
Multiple choice question.
Weighted average with the weights being the expected returns
Expected rate of return for the state most likely to occur
Summation of each expected return multiplied by its probability of occurrence
Weighted geometric average with the weights being the probabilities of occurrence
What type of relationship exists between risk and risk premiums?
Multiple choice question.
Inverse
None
Direct
Indirect
A stock has these expected returns: Boom economy = 15 percent; Normal economy = 8 percent;
Recession = -3 percent. The probabilities are: Boom = 10 percent; Normal = 85 percent; Recession = 5
percent. Illustrate the expected return calculation.
Multiple choice question.
E(R) = (0.10 × 0.15) + (0.85 × 0.08) + (0.05 × -0.03)
E(R) = (0.15/0.10) + (0.08/0.85) + (-0.03/0.05)
E(R) = (0.10 × 0.15) × (0.85 × 0.08) × (0.05 × -0.03)
E(R) = (0.15 × 0.08 × -0.03) + (0.10 × 0.85 × 0.05)
Asset pricing can be described as which type of process?
Multiple choice question.
Process of determining the spread required between a bid and asked price
Process of determining the price required for an asset to be immediately liquidated
Process of directly specifying an equation that relates a stock's required return to an appropriate risk
premium
Process of analyzing market forces to determine a stock's current value
There is a 5 percent chance of a depression, 25 percent chance of a recession, and a 70 percent chance
of a normal economy. A stock will return 45 percent in a depression, 36 percent in a recession and 5
percent in a normal economy. What is the expected return?
Multiple choice question.
14.75 percent
13.50 percent
11.25 percent
7.75 percent
Reason:
E(R) = (0.05 × 0.45) + (0.25 × 0.36) + (0.70 × 0.05) = 0.1475 = 14.75%
Select all that apply
Which of these statements related to the capital asset pricing theory (CAPM) is (are) correct? Select all
that apply.
Multiple select question.
CAPM provides higher expected returns than those found on the efficient frontier.
CAPM returns incorporate behavioral finance into efficient frontier returns.
The CAPM is derived from modern portfolio theory.
The key difference between CAPM returns and efficient frontier returns is the inclusion of a risk-free
rate.
Which one of these defines the standard deviation of expected returns given multiple economic states?
Multiple choice question.
Sum of the square root of each return's deviation from the average × Probability of that return
Sum of the square roots of each return's squared deviation from the average × Probability of that return
Square root of each return's deviation from the average × Probability of that return
Square root of the sum of each return's squared deviation from the average × Probability of that return
Which one of these is commonly used as a proxy for the market portfolio?
Multiple choice question.
U. S. Treasury Index
S&P Industrial Average
Dow Jones Industrial Average
S&P 500 Index
Select all that apply
The required return on a security is equal to which of these? Select all that apply.
Multiple select question.
Risk-free rate + Market risk premium
Real interest rate + Risk-free rate + Security's risk premium
Real interest rate + Expected inflation premium + Security's risk premium
Risk-free rate + Security's risk premium
How is risk premium defined?
Multiple choice question.
Market return - Expected inflation premium
A security's required return - Risk-free rate - Expected inflation premium
Required return - Risk-free rate
A security's required return - Market return
Beta is a a measure of a stock's sensitivity to which type of risk?
Multiple choice question.
Firm-specific risk
Diversifiable risk
Market risk
Total risk
True or false: Asset pricing can be defined as mathematically relating a security's required return to the
security's level of risk.
True false question.
True
False
What type of security, if any, has a zero beta?
Multiple choice question.
A risk-free security
No security can have a zero beta as all security's have some level of market risk.
The market portfolio
A highly-risky stock
Which one of these variables is used to measure compensable risk in the capital asset pricing model
(CAPM)?
Multiple choice question.
Standard deviation, σ
Alpha, α
Beta, β
Variance, σ2
Which one of these is a factor that most affects the level of a firm's beta?
Multiple choice question.
Firm's geographic location
Firm's line of business
Age of the firm
Firm size
Select all that apply
The market portfolio has which of these characteristics? Select all that apply.
Multiple select question.
No firm-specific risk
Is considered to be risk-free
Is part of the efficient frontier
Lies on the capital market line
The security market line (SML) graphs required return against which risk measure?
Multiple choice question.
Diversifiable risk
Total risk
Market risk
Firm-specific risk
How is required return defined?
Multiple choice question.
Market rate of return, usually considered to be the S&P 500 return
Total return investors demand as compensation for the risk taken
The historical average rate of return
The return on a security minus the risk-free rate
In the CAPM formula, what does the symbol RM stand for?
Multiple choice question.
Market risk premium
Risk-free rate of return
Beta
Market rate of return
Beta measures which of these?
Multiple choice question.
Comovement between a stock and the market portfolio
The amount of firm-specific risk that exists in a single security
Movement of a stock in response to a change in market interest rates
The total risk of an individual security
If you buy a stock with a beta of 1.5 when the risk-free rate is 2% and the market rate is 12%, what is
your expected rate of return?
Multiple choice question.
17%
10%
18%
14%
Reason:
E(R) = 0.02 + 1.5(0.12 - 0.02) = 0.17 = 17.00%
What does a beta of 1.0 mean for an individual security?
Multiple choice question.
The security is considered to be risk-free.
The security has 10 percent more market risk than the market portfolio.
The security has the same amount of market risk as the market portfolio.
The security has 10 times more market risk than the market portfolio.
If a stock has more market risk than the market portfolio and is overpriced, where will it plot on a
security market line graph?
Multiple choice question.
To the right of the market portfolio and below the security market line
To the right of the market portfolio and above the security market line
To the left of the market portfolio and above the security market line
To the left of the market portfolio and below the security market line
True or false: The stock of a firm which sells goods that are price elastic tend to have lower betas.
True false question.
True
False
You have a portfolio invested 40 percent in a stock A with a beta of 1.6, 30 percent in stock B, and 30
percent in a risk-free asset. What is the beta of stock B if the portfolio beta is equal to the market
portfolio beta?
Multiple choice question.
2.0
1.2
1.4
0.8
Reason:
The market beta is 1 while the risk-free beta is zero.
1 = (0.4 × 1.6) + (0.3 × βB) + (0.3 × 0); βB = 1.2
Select all that apply
Which of these are characteristics of the security market line (SML)? Select all that apply.
Multiple select question.
Vertical intercept at the market rate of return
Passes through the market rate of return
Upward-sloping function
Linear function
How is a portfolio beta computed when the portfolio consists of $800 in stock A with a beta of 2.6 and
$600 in a risk-free asset?
Multiple choice question.
βP =($800/$600)(2.6) + ($600/$800)(0)
βP = ($800/$1,400)(2.6) + ($600/$1,400)(1)
βP = ($800/$800)(2.6)
βP = ($800/$1,400)(2.6) + ($600/$1,400)(0)
Reason:
The portfolio beta is a weighted average with the weights equal to the
amount invested in each security divided by the portfolio value. The beta of
a risk-free asset is zero.
Select all that apply
Which of these are correct versions of the Capital Asset Pricing Model (CAPM)? Select all that apply.
Multiple select question.
E(R) = Rf + β(RM - Rf)
E(R) = Rf - β(RM)
E(R) = Rf + β(Market risk premium)
E(R) = Rf - β(Market risk premium)
The risk-free rate is 3.2 percent while the market risk premium is 8.9 percent. How is the expected return
for a stock with a beta of 0.98 computed?
Multiple choice question.
E(R) = 0.032 - 0.098(0.089 - 0.032)
E(R) = 0.032 + 0.98(0.089 - 0.032)
E(R) = 0.032 + 0.98(0.089)
E(R) = 0.032 - 0.098(0.089)
Reason:
The 8.9 percent is the market risk premium, not the market rate of return.
E(R) = 0.032 + 0.98(.089)
If you buy a stock with a beta of 1.43 when the risk-free rate is 2.4 percent and the market rate is 8.7
percent, what is your expected rate of return?
Multiple choice question.
10.04 percent
11.41 percent
18.27 percent
14.84 percent
Reason:
E(R) = 0.024 + 1.43(0.087 - 0.024) = 0.1141 = 11.41%
Select all that apply
Which of the following are sources for finding the beta of a stock? Select all that apply.
Multiple select question.
Yahoo! Finance
Nightly news broadcast
Value Line Investment Survey
Zacks
What does it mean if a stock plots on a security market line (SML) graph to the left of the market
portfolio?
Multiple choice question.
The stock is overpriced.
The stock has a beta greater than 1 and has more market risk than the market portfolio.
The stock is underpriced.
The stock has a beta less than 1 and has less market risk than the market portfolio.
You invest equal amounts of money in four stocks with betas of 1.4, 2.6, 0.3, and 0.7. What is the
portfolio beta?
Multiple choice question.
1.25
1.18
1.33
1.47
Reason:
βP = (1.4 + 2.6 + 0.3 + 0.7)/4 = 1.25; This can also be computed as a
weighted average with each weight being 0.25. The arithmetic method works
only because the weights are equal.
Select all that apply
How is the range of beta values defined for a portfolio of risky assets? Select all that apply.
Multiple select question.
The lowest possible portfolio beta is defined as the beta of a risk-free asset, or zero.
The highest portfolio beta is defined as the beta of the overall market, or 1.0.
The lowest possible portfolio beta is defined as the lowest beta of any security held in the portfolio.
The highest possible portfolio beta is defined as the highest beta of any security held in the portfolio.
A portfolio consists of $500 of stock A, $200 of stock B, and $600 of stock C. The stock betas are 1.3, 2.2,
and 0.5 for stocks A, B, and C, respectively. How is the portfolio beta computed?
Multiple choice question.
βP = (1.3 + 2.2 + 0.5)/3
βP = ($500/$1,300)(1.3) + ($200/$1,300)(2.2) + ($600/$1,300)(0.5)
βP = (0.5 × 1.3) + (0.2 × 2.2) + (0.6 × 0.5)
βP = ($500/$800)(1.3) + ($200/$1,100)(2.2) + ($600/$700)(0.5)
Which one of these can be used as a definition of an efficient market?
Multiple choice question.
Securities market where stocks are traded free of cost
Securities market where stock prices are unaffected by changes in a firm's level of risk
Securities market where any stock can be listed on any exchange
Securities market where prices accurately value the risk-return relationship of each security given all
available information
A stock has a beta of 1.2, the market rate of return is 11.3 percent, and the risk-free rate is 4.2 percent.
How is the expected return on the stock computed?
Multiple choice question.
E(R) = 0.042 + 1.2(0.113 - 0.042)
E(R) = 0.042 - 1.2(0.113 - 0.042)
E(R) = 0.042 + 1.2(0.113 + 0.042)
E(R) = 0.042 + 1.2(0.113)
Which one of these defines the efficient market hypothesis (EMH)?
Multiple choice question.
A theory that explains the time delays inherent in an efficient securities market
A theory that outlines all the conditions necessary for a securities market to be efficient
A theory that determines the number of market makers necessary for an efficient market
A theory that describes what types of information are reflected in current market prices
Select all that apply
Which of the following help explain why beta values on the same stock can vary, if in fact they do vary?
Select all that apply.
Multiple select question.
Returns for different reporting intervals were used, i.e., weekly versus monthly returns
The beta value on a single stock will remain constant over time.
A different index was used as the market portfolio, i.e., the Wilshire 5000 versus the S&P 500
A different time period was used, i.e., 1997-1999 versus 1998-2000
Which one of these correctly defines a level of market efficiency?
Multiple choice question.
Weak form: Prices reflect all information, both public and private
Weak form: Prices reflect all public information
Semi-strong form: Prices reflect all historical and public information
Strong form: Prices reflect all historical and public information
If a stock has more market risk than the market portfolio and is overpriced, where will it plot on a
security market line graph?
Multiple choice question.
To the right of the market portfolio and below the security market line
To the left of the market portfolio and below the security market line
To the left of the market portfolio and above the security market line
To the right of the market portfolio and above the security market line
If the market is weak-form efficient, it renders useless which of the following?
Multiple choice question.
fundamental analysis
technical analysis
insider trading
Which one of these correctly defines a portfolio beta? Assume varying amounts are invested in each
security.
Multiple choice question.
Arithmetic average of the individual security betas
The highest beta of any stock held in the portfolio
A beta equal to the market portfolio beta
Weighted average of the individual security betas
Which one of these is an argument for market efficiency?
Multiple choice question.
The research findings of behavioral finance advocates
Investors who are overly confident and thereby cause market prices to be overvalued based on their
expectations
Investors constantly seek mispriced stocks and cause that mispricing to disappear by their trades
The existence of market bubbles for an extended period of time
What is the definition of an efficient market?
Multiple choice question.
Securities market where everyone who wants to participate in the market can participate
Securities market where trades occur within ten minutes of an order being placed
Securities market in which prices fully reflect available information on each security
Securities market where stock prices become stable over time
Select all that apply
Which of these are characteristics associated with a stock market bubble? Select all that apply.
Multiple select question.
Sustainable price increases
Period of steady prices
Investor enthusiasm
Inflated bull market
Which one of these statements applies to the efficient market hypothesis (EMH)?
Multiple choice question.
Security prices overreact and then settle to a price reflective of the latest information.
Security prices are random.
Security prices fully reflect all available information.
Security prices only reflect historical and public information.
The study of behavioral finance suggests that markets may not be priced efficiently for which one of
these reasons?
Multiple choice question.
Investors may make irrational decisions.
New information is hard for investors to obtain and interpret.
There is a lack of market participation.
Investors are always pessimistic and thus prices are too low.
Kate, a corporate controller, knows her firm's earnings are going to be less than the market expects. The
firm's stock price includes all information except for this. What form of market efficiency exists?
Multiple choice question.
Semi-strong form
Strong form
Weak form
Select all that apply
Why do managers need to understand shareholder's required returns? Select all that apply.
Multiple select question.
Managers must understand that increasing the risk level of a firm will increase the returns required by
investors.
Managers must include shareholder returns in new project analysis.
Managers must also be shareholders and thus they want to be adequately compensated.
Managers must ensure firms adequately reward their investors.
Lucas was just charged with insider trading. What form of market efficiency cannot exist if this charge is
true?
Multiple choice question.
The strong form of efficiency cannot exist.
Neither the weak-form nor the semi-strong form of efficiency can exist.
All forms of market efficiency can still exist.
The weak form of efficiency cannot exist.
A stock just paid an annual dividend of $1.34 which increases by 2 percent per year. How do you
compute the required return if the stock is selling for $43 a share?
Multiple choice question.
i = [($1.34 × 1.02)/$43] + 0.02
i = ($1.34/$43) + 0.02
i = ($1.34 × 0.02)/$43 + 0.02
i = ($1.34 × 1.02)/$43
Trading based on which one of these is an argument against market efficiency?
Multiple choice question.
Past price trends
New public information
Psychological bias
New privately-held information
How is a stock market bubble defined?
Multiple choice question.
Period of overinflated prices followed by a dramatic collapse in prices
Long period of rising prices followed by a period of slow growth
Period of slowly rising prices that suddenly decline due to firm-specific risk
Long, slow period of price increases followed by a slow decline in prices
Which of these is the study of the cognitive processes and biases associated with making financial and
economic decisions?
Multiple choice question.
Behavioral finance
Executive options
Managerial implications
EMH theory
True or false: For firms to be able to sell shares of stock, their managers must understand the returns
required by shareholders.
True false question.
True
False
Which one of these formulas correctly computes the return required by an investor?
Multiple choice question.
i = (D1/P0) + g
i = (D0/P1) + g
i = D1 + g
i = D0/P0 + g [Show Less]